Management’s Discussion and Analysis of Financial Condition and Results of Operations.
BUSINESS AND OVERVIEW
We are a worldwide operator and franchisor of 3,545 properties (618,104 rooms) and related facilities. The figures in the preceding sentence are as of year-end 2010 and include 34 home and condominium products (3,391 units) for which we manage the related owners’ associations. In addition, we provided 2,043 furnished corporate housing rental units, which are not included in the totals.
Our operations are grouped into five business segments: North American Full-Service Lodging, North American Limited-Service Lodging, International Lodging, Luxury Lodging, and Timeshare. We operate, develop, and franchise under numerous separate brand names in 70 countries and territories.
We earn base, incentive, and franchise fees based upon the terms of our management and franchise agreements. We earn revenues from the limited number of hotels we own or lease. We also generate revenues from the following sources associated with our Timeshare segment: (1) selling timeshare interval, fractional ownership, and residential properties; (2) operating the resorts and residential properties; (3) financing customer purchases of timesharing intervals; and (4) rentals. Finally, we earn fees in association with affinity card endorsements and the sale of branded residential real estate.
During 2010 we broadened our timeshare interval product offering to include the sale of the points-based Marriott Vacation Club Destinations timeshare program in North America and the Caribbean. The Marriott Vacation Club Destinations timeshare program offers greater flexibility, further personalization and more experience opportunities for participating timeshare owners. See the “Marriott Vacation Club Destinations Timeshare Program” caption later in this Form 10-K for additional information.
We sell residential real estate either in conjunction with luxury hotel development or on a stand-alone basis under The Ritz-Carlton brand (The Ritz-Carlton Residences) and in conjunction with Timeshare segment projects (The Ritz-Carlton Destination Club and Grand Residences by Marriott-Residential). Our Timeshare segment residential projects are typically opened over time. Other residences are typically constructed and sold by third-party developers with limited amounts, if any, of our capital at risk. While the worldwide residential market is very large, the luxurious nature of our residential properties, the quality and exclusivity associated with our brands, and the hospitality services that we provide, all serve to make our residential properties distinctive.
Business conditions for our lodging business improved in 2010. While the recent recession significantly impacted lodging demand and hotel pricing, occupancies began to improve late in 2009 and that improvement continued throughout 2010. Room rates began to stabilize and improve in some markets in the 2010 second quarter, and that improvement continued, strengthened and expanded to other markets throughout the rest of 2010. In 2010, worldwide average daily rates on a constant dollar basis stayed the same as 2009 for company-operated properties. Worldwide RevPAR for company-operated properties increased 6.3 percent on a constant dollar basis for 2010, as compared to 2009, and occupancy increased 4.1 percentage points to 68.7 percent.
While worldwide RevPAR for 2010 remained well below 2008 levels, we continued to see strengthening in properties in Asia, Europe, the Caribbean, Latin America, and in our luxury properties around the world. Our hotels in Asia are particularly benefitting from strong economic growth in that region. Additionally, hotels in North America experienced stronger demand from corporate transient and association group customers in 2010 as compared to 2009, and that demand continued to strengthen progressively during the 2010 period. However, property-level banquet and catering spending continues to be weak primarily reflecting tight budgets and fewer group functions; although we did experience some improvement late in 2010. During the 2010 first quarter, group meeting cancellations declined to typical levels, and expected revenue from group meetings continued to improve throughout 2010. While our booking windows for both group business and transient business remain very short, our pace of bookings for group business for future periods continued to improve throughout 2010.
We monitor market conditions continuously and carefully price our rooms daily to meet individual hotel demand levels. We modify the mix of our business to increase revenue as demand changes. Demand for higher rated rooms improved in 2010, which allowed us to reduce discounting and special offers for transient business. This mix improvement benefited average daily rates at many hotels.
Negotiated corporate business (“special corporate business”) represented 14 percent of our full-service hotel room nights for 2010 in North America. By late 2010, demand trends had further strengthened, and we had negotiated rates with more than two-thirds of our 2011 special corporate rate clients. Those rates were meaningfully higher than those we negotiated in 2009 and early 2010. We typically negotiate and fix room rates associated with special corporate business in advance of the year to which they apply, which limits our ability to raise these rates quickly. We expect to complete negotiations with our remaining special corporate business clients in the 2011 first quarter. In negotiating pricing for this segment of business, we do not focus strictly on volume, but instead carefully evaluate the relationship with our customers, including for example, stay patterns (day of week and season), locations of stays, non-room spend, and aggregate spend.
Group business pricing is also inflexible in the near term, as some group business may be booked several years in advance of guest arrival. However, as a result of the recent recession, shorter group booking windows became more common for 2010 than they were in prior years. Accordingly, with strengthening demand, group business booked in 2010 showed stronger price improvement than business booked in 2009, and “in-the-year-for-the-year” bookings also increased in 2010.
Properties in our system are maintaining very tight cost controls, as we continue to focus on enhancing property-level house profit margins. Where appropriate for market conditions, we have maintained many of our 2009 property-level cost saving initiatives such as adjusting menus and restaurant hours, modifying room amenities, cross-training personnel, utilizing personnel at multiple properties where feasible, and not filling some vacant positions. We also reduced above-property costs, which are allocated to hotels, by scaling back systems, processing, and support areas. In addition, we have not filled certain above-property vacant positions, and have required where legally permitted and elsewhere encouraged employees to use their vacation time accrued during 2010.
Our lodging business model involves managing and franchising hotels, rather than owning them. At year-end 2010, we operated 45 percent of the hotel rooms in our system under management agreements, our franchisees operated 53 percent under franchise agreements, and we owned or leased 2 percent. Our emphasis on long-term management contracts and franchising tends to provide more stable earnings in periods of economic softness, while the addition of new hotels to our system generates growth. This strategy has allowed substantial growth while reducing financial leverage and risk in a cyclical industry. In addition, we increase our financial flexibility by reducing our capital investments and adopting a strategy of recycling the investments that we make.
We consider RevPAR, which we calculate by dividing room sales for comparable properties by room nights available to guests for the period, to be a meaningful indicator of our performance because it measures the period-over-period change in room revenues for comparable properties. RevPAR may not be comparable to similarly titled measures, such as revenues. References to RevPAR throughout this report are in constant dollars, unless otherwise noted.
Company-operated house profit margin is the ratio of property-level gross operating profit (also known as house profit) to total property-level revenue. We consider house profit margin to be a meaningful indicator of our performance because this ratio measures our overall ability as the operator to produce property-level profits by generating sales and controlling the operating expenses over which we have the most direct control. House profit includes room, food and beverage, and other revenue and the related expenses including payroll and benefits expenses, as well as repairs and maintenance, utility, general and administrative, and sales and marketing expenses. House profit does not include the impact of management fees, furniture, fixtures and equipment replacement reserves, insurance, taxes, or other fixed expenses.
For our North American comparable properties, systemwide RevPAR (which includes data from our franchised, managed, owned, and leased properties) increased by 4.9 percent in 2010, compared to 2009, reflecting improved occupancy levels in most markets, partially offset by a modest decline in average daily rates. For our properties outside North America, systemwide RevPAR for 2010 increased 9.2 percent versus 2009, reflecting improved occupancy levels, partially offset by a modest decline in average daily rates.
We launched the points-based Marriott Vacation Club Destinations timeshare program (“MVCD Program”) in North America and the Caribbean in June 2010, and we are initially focusing our marketing efforts on existing customers. As a result, in 2010, contract sales to existing owners increased 31 percent while sales to new customers declined. We expect accelerated sales to new customers in 2011. See the “Marriott Vacation Club Destinations Timeshare Program” caption later in this Form 10-K for additional information.
Contract sales for our timeshare, fractional, and residential products increased modestly in 2010, compared to 2009, largely due to a decline in contract sales cancellation allowances. We adjust our contract sales for cancellation allowances that we record in anticipation that a portion of contract revenue previously recorded for certain residential and fractional projects would not be realized due to pre-closing contract cancellations. At the same time, contract sales were constrained by difficult comparisons driven by sales promotions begun in 2009. By the end of 2010, timeshare pricing improved because we had largely discontinued or reduced the purchase incentives and targeted marketing efforts instituted in 2009.
Rental revenues increased in 2010 with stronger leisure demand for our Marriott Vacation Club product and greater available rental inventory. Demand for fractional and residential units remains weak. Sales and marketing costs as a percentage of contract sales continue to improve. As with Lodging, our Timeshare properties continue to maintain very tight cost controls, and we have not filled certain vacant positions, and have required where legally permitted and elsewhere encouraged employees to use their vacation time accrued during 2010.
Since the sale of timeshare and fractional intervals and condominiums follows the percentage-of-completion accounting method, current demand may not always be reflected in our Timeshare segment results until later accounting periods.
On January 2, 2010, the first day of our 2010 fiscal year, we adopted the new Transfers of Financial Assets and Consolidation standards. As a result of adopting these standards in the 2010 first quarter, we consolidated 13 existing qualifying special purpose entities associated with past securitization transactions, and we recorded a one-time non-cash after-tax reduction to shareholders’ equity of $146 million ($238 million pretax) in the 2010 first quarter, representing the cumulative effect of a change in accounting principle.
See Footnote No. 1, “Summary of Significant Accounting Policies,” of the Notes to our Financial Statements for more detailed information on our adoption of these new accounting topics, including the impact to our Balance Sheet and Statement of Income.